No, that’s not a date from Star Trek. It’s a budgeting rule. Since we’re getting close to the new year, I thought I would share one simple financial planning/budgeting idea you might consider for your new year. Here it goes….
What is 50/30/20
50/30/20 is a budgeting framework that helps you to budget your after-tax income. Here’s the idea. 50% of your after-tax income should be spent on your fixed expenses. This includes things like your mortgage or rent payment, car payments, insurance, utilities, groceries, minimum debt payments and must haves, such as internet.
30% of your after-tax income is to be used on wants. This includes things like eating out, buying nicer clothes, vacations, or an electronic drum set.
20% goes towards savings. This includes retirement plan contributions, adding to an emergency fund or making additional payments to a credit card or other debt.
That’s the framework. Let’s take a look at a numerical example then we can discuss it a little bit.
Annual Income | Monthly Pre-Tax | Monthly After-Tax |
$100,000 | $8,333 | $6000 |
50% Fixed Expense |
| $3000 |
30% Wants |
| $1800 |
20% Savings |
| $1200 |
I’m using $100,000 because it’s a nice round number. I looked up the take home pay of someone making $100,000 and depending on where you live, I think I’m pretty close. Here are a couple of observations.
- Most people’s biggest expenses are housing, cars, and food. If you have $3000.00 per month to spend on these three items, you must be very careful not to buy more house than you can afford, be careful on what you spend for a car and shop carefully.
- When you look at numbers like these, it’s no wonder most Americans don’t have enough saved for retirement.
- I doubt many people actually save 20% of their take home pay. I read where the average 401k contribution is 7% of people’s gross income which would work out to a little less than 10% of their take home pay.
- I bet most budget ratios are closer to 70/23/7. Recent inflation and rising interest haven’t helped this at all lately.
What Can You Do
- Know where you are spending your money and figure out your ratios. We use a budgeting program called YNAB. This allows us to tell our money where to go versus wondering where it went. It also has reports so I can easily figure out our ratios. At this point in my life, I spend more on the fixed expenses and the savings and less on the wants.
- Get rid of monthly subscriptions and fees that you don’t use. Look through your bank and credit card statements. It’s easy to pick up a gym membership here, a wine club there, a cable package that you never use and maybe a few newspaper or magazine subscriptions. Why pay for stuff you’re not using. Call the place up and cancel. $40.00 here and $25.00 there and pretty soon you’re talking about serious money.
- Eat at home. Drink at home. If you go out to eat, drink water. Wine is expensive at restaurants. Budget for dining out, but don’t overdo it.
- Sell your car! Drastic, but it could be an option.
- Credit cards, interest rates, car payments, etc. I could write a complete article on this subject alone. Call the credit card companies and ask them to reduce your interest rate. If you have a credit card with a balance, look into doing a balance transfer to a lower rate. You get the idea.
- Improve your credit score!! The most important parts of your credit score are your payment history and your credit card usage. You can’t do too much about your past payment history, but you can make sure you’re not late going forward. You can adjust your credit card, so it automatically draws out the minimum payment each month. That will avoid a late payment, a late fee, and a derogatory mark on your credit score. With an improved credit score, it’s easier to get lower rates or even add a credit card so your usage rate goes down. Be careful with that one. You don’t want to run up more credit card debt!!!
New Year’s Resolution
50/30/20 isn’t an end all, be all. It’s more of a framework or outline to get your spending under control and encouraging you to save more money for your future. I still think most people have no idea how much money they are spending. People buy houses and only think about the mortgage payment. But owning a house costs a lot more than just the monthly payment. Plus, we get sold a lot of stuff based on a monthly payment. The average price of a new car is $48,000, but you can buy it for $775.00 per month and your first payment isn’t due until February!! You don’t realize that will spend $55,800 for your $48,000 car!
The average price of a home in Albuquerque was $330,000 in November of 2022. If you buy that house, your payment will be over $2000.00 per month. If you add the new car payment, suddenly your budget is all out of whack.
If you’re young and starting out, you can use this framework to reverse engineer how much house you can afford. Instead of getting lured in by the new car smell and a low monthly payment that’s spread out over 6 years, buy a reliable used car and either pay cash or shorten up the loan term. Know how much you spend on food and balance eating at home and going out once or twice a week.
If you’re a full time adult and you’ve been playing the game for a while, you can use the 50/30/20 as an aspirational road map. See where your money is going and compare it to the framework. Look for ways to save money. Reduce wasteful spending. Drink water at dinner and have a glass of wine when you get home. Improve your credit score. Lower interest rates. Sell the car!
I love looking at this stuff. I get excited when I’m talking to clients, and they can see things are going to be fine or even better than fine. If you want to start off the New Year on the right foot, reach out to me HERE. I would love to help you! As always, thanks for reading. Happy New Year! KB